What’s the Total Cost of that Loan?

Interest rates on loans vary tremendously. For example, the benchmark 30-year fixed-rate mortgage loan rate is 4.01%, according to Bankrate's recent survey of large lenders. In contrast, a vehicle title loan's annual percentage rate is often over 200%!

What is a title loan? Auto title loans are high-cost, relatively small dollar loans. A person's vehicle serves as collateral for the title loan. If a title loan is not paid on time, then the car owner risks losing their vehicle, and transportation to work, health care, and other daily needs.

A recent report from the Woodstock Institute and Illinois Asset Building Group, "No Right Turn: Illinois' Auto Title Loan Industry and its Impact on Consumers," describes the challenges of title loans. In 2013, the average annual percentage rate (APR) charged on a title loan in Illinois was 234%, with an average loan time period of 18.6 months. On average people borrowed $1,089 and paid over $3,000 in fees on these relatively small loans. In 2013, 100,698 title loans were made in Illinois.

Illinois does regulate auto title lending; for example, loans cannot exceed $4,000. No monthly payments for a title loan can exceed 50% of the borrower's income, and balloon payments aren't allowed. Illinois does not regulate the interest rate charged.

Who uses title loans? The vast majority of title loan borrowers in Illinois are low-income people. Title loans are easy to get and are publicized everywhere. It's easy during times of crisis or high stress for people to turn to title loans to meet immediate needs.

Unfortunately, while it's easy to borrow money with a title loan, it's very hard to pay back these high interest loans. In one example given in the No Right Turn report, $9,166 was paid for a two year loan for $1,500 at 304% interest cost. People do pay back these loans but it's a high price to pay.

Title loans are an excellent example of why it's important to understand the full pay-back cost of a loan: the amount you're borrowing, the interest charges, and all fees. The annual percentage rate (APR) of a loan lets you compare the cost of two different loans. (The loan APR takes into account the loan interest rate as well as fees.) Always ask about the APR when borrowing money and shop around – no matter if you're looking for a small loan, a student loan, or a large home mortgage loan.

Of course having savings for emergencies is ideal. But sometimes financial challenges are larger or go on longer than people plan, and savings can run out. In these cases, exploring other borrowing options is important. Sometimes families or friends can help out. Many credit unions and some banks will make small loans to their customers. Unfortunately, 22% of Illinoisans lack adequate banking services, according to the FDIC, and this option may not be available to them.

When life is challenging and money is tight, a loan that is quick and easy to get might sound perfect. But it's important to understand the long-term cost of title loans, and to consider other options. Always shop around for loans and ask about the total cost of the loan before you borrow money.